A short guide to investment risk
This content is for information purposes only and should not be taken as financial advice. Every effort has been made to ensure the information is correct and up-to-date at the time of writing. For personalised and regulated advice regarding your situation, please consult an independent financial adviser here at Castlegate in Grantham, Lincolnshire or other local offices.
Regardless of what you do with your money, there are risks involved. Keeping cash in regular savings risks erosion by inflation. Putting it into shares involves the risk of the value falling in a bear market. Rather than trying to eliminate risk to your wealth (which is impossible), therefore, financial planning aims to limit needless risks and help you move towards your goals in a way that you feel comfortable.
Below, our financial planners at Castlegate in Grantham, Lincolnshire offer this short guide to different aspects of investment risk and how to navigate them. We hope you find this content helpful. If you want to discuss your own financial plan with us, please get in touch to arrange a no-obligation financial consultation, at our expense:
01476 855 585
info@casfin.co.uk
#1 Liquidity risk
When you invest in shares or store wealth as cash, you can often take your money out quickly (if needed). You simply need to log in and make a withdrawal. This is called “high liquidity” and can be very useful for certain situations. For instance, having £15,000 in easy-access regular savings could help to tide you over if you suddenly lost your job and needed to find new work.
Other assets are harder to dispose of quickly. Property is often considered a strong investment, yet its drawback is that it can take many months to close a sale. Venture capital trusts (VCTs), moreover, can offer strong potential returns for investors prepared to take on more risk, but can be difficult to find buyers. Be careful, therefore, not to tie up too much wealth with low liquidity assets that might constrain your decisions later.
#2 Opportunity cost risk
When you commit money to a particular asset (e.g. cash or bonds), then it will be “stored” in it for some time – potentially years – while you seek to generate a return from it. This means that the money cannot be committed to another asset which might perform better over that period. Sadly, there is no way to guarantee, ahead of time, which investments will perform the best.
However, investors can use established insights about different asset types to build a portfolio with the best chance of avoiding needless opportunity costs. For example, if you store lots of wealth in cash, there is a very high chance that it will lose value – in real terms – over the years, since interest rates are unlikely to keep up with inflation (now 10.1%). Investing in a diversified portfolio of shares (and perhaps bonds), however, could give you a better chance of producing inflation-beating returns – assuming factors such as a long investment horizon, performance and investor discipline.
#3 Volatility risk
One advantage of cash is that it avoids the ups and downs of the stock market. However, it can still rise and fall due to inflation (which has risen quickly in 2022), and international exchange rates affect the value of the GBP abroad. Indeed, all assets have a volatility risk that must be managed by investors.
Property prices rise and fall due to housing market forces, for instance. The price movements of stocks and shares can be seen more clearly, in real time, when you log into an exchange. This is where having a diversified portfolio of assets can help, since different asset values can move in different directions. When stocks fall, for instance, bonds often rise as more investors seek “safety” from further falls in the market.
#4 Company/fund risk
When investing in shares, you have two broad choices. You can invest directly into one or more specific company stocks; or, you can invest into one or more funds (which pool your money with other investors to invest in multiple stocks). Generally, most investors should limit investing in individual stocks. It is very difficult to predict which ones will perform well, and if a company fails then you could lose your entire investment.
Investing in a fund, however, typically carries a higher degree of diversification. If one company within the fund fails, then the others should help protect the value of your investment. However, funds can still fail if their “fundamentals” are poor. The Woodford Equity Income fund is a case in point. Suspended in 2019, the fund collapsed and lost millions for investors after years of falling performance (partly due to its high concentration of private unlisted companies).
Here, financial advice can help you sort through the wide range of available funds (there are over 4,000 in the UK!) and rule out those with “shaky” fundamentals, allowing you to sift down to a list of viable candidates for your portfolio. Diversifying across a range of companies, markets and countries can help you access more opportunities and mitigate some of the risks associated with each one. Be careful not to “over diversify”, however, as this can dilute your returns.
Invitation
If you are interested in discussing your own financial plan or investment strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:
01476 855 585
info@casfin.co.uk
